A nonrecourse debt is a type of loan that is secured by collateral, usually real property, in which the borrower is not held liable personally for repaying the loan. If the borrower defaults, only the collateral may be recovered by lender. If the value of the collateral does not cover the loan balance, such as in the case of real estate values dropping since the loan was first arranged, the lender simply loses the difference, and has no recourse in the transaction.
Because the lender in a nonrecourse debt has a higher stake in the collateral retaining or increasing its value, these loans are generally limited to 80% to 90% loan-to-value ratios, in essence providing overcollateralization for the loan.
These loans are primarily used to finance commercial real estate and other projects with high capital expenditures, uncertain cash flow or long loan periods. Since most commercial real estate involves partnerships, nonrecourse debt has the additional benefit of limiting the partners’ personal liability and while also offering the tax benefits of a tax-pass-through structure. Nonrecourse debt is usually classified a liability on a company’s balance sheet, while the collateral is considered as an asset.
Lenders of non-recourse loans depend on accurate assessments of the borrower’s credit, and a thorough knowledge of technical issues involved, along with considerable financial modeling expertise.
Lastly, with nonrecourse debt, the tax consequences for borrowers that default and have their collateral seized can be complicated, but generally they cannot claim a tax loss any greater than the amount of equity in the loan.
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